The term ‘ESG’ has garnered a little bit of traction in the world of business over the past decade. It refers to a number of criteria by which ethically conscious investors judge the businesses they’re considering investing in.
ESG initiatives can also help manufacturers deal with issues that aren’t strictly ethical – such as resilience to sudden shocks in the supply chain, such as those brought about by the covid-19 pandemic.
Keeping things Sustainable
Businesses have never been under greater pressure to keep their operations environmentally friendly and sustainable. This pressure is exerted both by government and by consumers. Every business wants to be seen as environmentally conscientious. Given that younger generations are more likely to care about environmental issues, it follows that this trend isn’t going to die away any time soon.
What are the challenges?
Squire Patton Boggs is a legal firm specialising in mergers and acquisitions. Together with the University of Leeds Business School, they’ve produced a report on how the key ESG challenges might be overcome. The report picks out five ‘pillars’ that should form the central structure of a business’s ESG plans. These are resilience and innovation; supply chains and customers; organisational behaviour; diversity and inclusion; and sustainability.
How does ESG actually work?
When assessing the ESG impact of a given company, investors look at a whole range of criteria. Unsurprisingly, these can mostly be lumped into the three categories from which ESG takes its name: Environmental, Social and Governance.
Environmental factors might include energy efficiency, waste, and pollution. Industries that involve large tracts of land, such as agriculture, might be judged on the opportunity cost imposed by the use of this land.
Social criteria might cover the company’s impact on the local community, and its regard for the health and safety not just of its employees, but of the general public.
Governance factors might cover the company’s accounting methods, and the ability of stakeholders to influence the direction of the company. It also seeks to eliminate potential conflicts of interest and perverse incentives among board members.
In the eyes of some ESG advisors, these concerns aren’t just ethical. Poor performance in ESG could signal potential risk factors. Businesses with opaque governance are more likely to run into scandals and insider trading, for example. You might consider the Volkswagen emissions scandal of 2015, which severely impacted the company’s share price and hurt investors associated with it. Had ESG-friendly structures been in place, it is posited, this might not have happened.
Still, there’s reason to be wary of ESG – especially where it’s used to outsource critical scrutiny. For investors, there’s no substitute for diligent research.